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Flowchart for a typical DCF valuation, with each step detailed in the text (click on image to see at full size) Spreadsheet valuation, using free cash flows to estimate the stock's fair value, and displaying sensitivity to WACC and perpetuity growth (click on image to see at full size)
The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by the external market and not by management.
Alternatively, the method can be used to value the company based on the value of total invested capital. In each case, the differences lie in the choice of the income stream and discount rate. For example, the net cash flow to total invested capital and WACC are appropriate when valuing a company based on the market value of all invested ...
c = cost of capital, or the weighted average cost of capital (WACC). NOPAT is profits derived from a company's operations after cash taxes but before financing costs and non-cash bookkeeping entries. It is the total pool of profits available to provide a cash return to those who provide capital to the firm.
The formula adds up the negative cash flows after discounting them to time zero using the external cost of capital, adds up the positive cash flows including the proceeds of reinvestment at the external reinvestment rate to the final period, and then works out what rate of return would cause the magnitude of the discounted negative cash flows ...
The CROCI/WACC ratio is basically the same metric signaling value creation or destruction. If the ratio is higher than 1, a company creates value, and it destroys value if the ratio is below 1. CROCI can be compared to a company's economic price to book (broadly equivalent to a company's Tobin's Q ) to calculate an Economic P/E.
If N is the 5th and final year in this period, then the Terminal Value is divided by (1 + k) 5 (or WACC). The Present Value of the Terminal Value is then added to the PV of the free cash flows in the projection period to arrive at an implied enterprise value.
Calculation of WACC is an iterative procedure which requires estimation of the fair market value of equity capital [citation needed] if the company is not listed. The Adjusted Present Value method (APV) is much easier to use in this case as it separates the value of the project from the value of its financing program.